One of the great advantages of the free market economy is that it adjusts quickly and with the greatest possible efficiency to endogenous and exogenous shocks that happen or are expected to happen. By contrast, the public sector, due to its structure, responds with long lags and typically asymmetric ways because, when the govern- ment decides to intervene to correct a problem, it takes long to act and in the
meantime the markets in question have changed since the problem was first noticed.
So the remedy may worsen than improve the situation. By implication, as the state expanded, the rigidities in its operation spread throughout the economy, with the consequence that the latter lost its flexibility to return to equilibrium after some shock in the resilient way it did so in earlier times.
The expansion of the state spread rigidities to the economy through still another channel. This is the activities of the powerful labour unions, which managed to extract from government job security and horizontal pay scales and privileges.
These, on the one hand, provided little or no incentives to increase productivity through greater work effort in the state sector,42 and on the other, they set the standards for the demands of the labour unions in the private sector, thus reducing its competitiveness and growth potential. In particular, as the state grew and turned into one of the main employers in the economy, it was to be expected that it would stir up incentives for civil servants and other government employees to form labour unions and to raise their bargaining power. As a result, in state sectors in many countries emerged massive labour monopolies, which eliminated competition from a large segment of the labour markets. This development, in conjunction with the realisation that governments in representative democracies are generally weak and the managements in state-owned enterprises and organisations are usually appointed by governments, converted labour unions in the narrow and the wider state sectors into mechanisms of stirring turbulence in the economy and unfortu- nately always in one direction, that is, in the direction of constantly increasing the unit labour cost and disassociating it from the productivity of workers in the state sectors. Moreover, if this hardening of labour markets were not enough, it spread to the private sector via a deliberate policy of replacing individual contracts by collective ones, not at least at the level of the enterprise but at the levels of the particular industry or sector. Thus, after many decades during which governments introduced or sanctioned the introduction of rigidities in the labour markets, it is no surprise that in recent years, economists and international organisations have concluded that wages are no longer formed competitively and that the governments need to introduce measures to increase the flexibility of labour markets.43
Finally, rigidities were introduced from various highly invasive policies. In all such cases, the affected markets were dichotomised into “official” and “parallel or underground” and lost the ability to yield their first best results for the economy.
42See, for example, the paper by Marimon and Zilibotti (1999) and the literature to which they refer.
43Empirical studies that compare the level of unemployment in the USA and Europe have found that in the labour markets of the latter exist major rigidities, which come not only from labour unions but also from regulatory policies. For example, two of the many reasons to which these rigidities have been attributed are the insistence of European governments in the policies of the minimum wage and the subsidies for unemployment. The results have been less growth, higher unemployment, especially among youth, and wage inequality (related analysis and literature can be found in Bitros and Prodromidis 2004). Instead, by researchers such as Johnson (1980), it has been proposed to replace subsidies to the unemployed by wage subsidies and training.
Here we have the opportunity to stress that rigidities of this form are introduced from the restrictions that states impose on the production, distribution and con- sumption of goods and services such as, for example, drugs, prostitution and gambling. Prohibiting by law an individual to dispose of his body or to exchange his goods and labour according to his wishes, the state violates his property rights.
Consequently, since such restrictions limit the set of all potential transactions, de facto the affected markets in the economy cannot achieve an allocation of goods and services consistent with the wishes of citizens. That is why, in our view, the only justified restrictions on the part of the state are those that have a positive social balance in the sense that a cost–benefit analysis would show that they are accompanied by an excess of “social benefits”. Based on this approach, all bans on individual activities that have no adverse effects on third parties should be abolished and in those that will be retained the functions of the state should be converted from “active” to “passive”.44 For example, rather than banning the consumption of alcohol by minors, it would be far more effective not to provide government assistance to those that get involved in car accidents. The reason is that the current policies increase “moral hazard” since the negligence of individuals to take care of themselves or their tendency to assume increased risks is motivated by the knowledge that, in case something happens to them, somebody else will cover their costs, namely, the taxpayer.
Another adverse effect of state interventions is the cost they impose on individuals and businesses. This cost is high because state interventions distort the markets to which they apply and also because of the resources that are required for enforcement and compliance. For example, in the USA, it is estimated that the total cost of regulation is about 9 % of GDP, of which 7 % is absorbed by households and businesses (see Blundell and Robinson 1999, 3–4). Although we have no data for the European Union, the time-consuming requirements for doing business, in conjunc- tion with the vast bureaucracy that dominates in most member states, should add comparatively more to the cost of goods and services produced, thus eroding their international competiveness. Moreover, as we noted earlier, we should not forget that many of the regulations emanate from the clientelist relationship between organised interests and politicians, on the one hand, and state services, on the other.
Lastly, it should be stressed that many of the objectives pursued by state interventions can be and are usually achieved more effectively by markets them- selves. An example in this regard refers to markets in which businesses commit to certain basic characteristics of the goods and services they offer, and then, to gain the loyalty of customer and preserve reputation, they maintain the standards of quality in a stricter manner and at a lesser cost to society than any state monitoring agency could manage. But this is by no means the only case. A few other examples are the ship registries and the various national and international institutes which certify the quality standards of products and processes, like the International Organization for Standardization (ISO-9000) in Europe and the Underwritten
44As found by Meadowcroft (2008), the trend today is in this direction.
Laboratories in the USA. All of them are regulatory mechanisms created endoge- nously by markets themselves for the purpose of ensuring a level playing field among the companies that participate.45